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August 4, 2014

Opening of Saudi Bourse Increases Investment Appeal

Saudi Arabia’s decision to open up its stock market to foreign investors is an important event for investors in the Middle East and North Africa (MENA) region.

Many of those investors have been waiting for direct access to the large, well developed and strong Saudi Arabian market, said Richard Segal, head of emerging markets fixed income strategy at Jefferies in London. Until now, foreigners could only own Saudi names through ADRs, listings on exchanges in the United Arab Emirates or via synthetic SPVs. Now, they can directly buy top-notch companies in a number of sectors, that in this tragic time of great strife and uncertainty in the Middle East, are proving to be a safe haven to many MENA investors, Segal said. In addition to being able to now buy these names directly, the Saudi riyal is also pegged to the U.S. dollar, so investors don’t have to worry about currency risk, Segal said.

Now, many investors are wondering which index Saudi Arabia will become a part of. Should it be classified as an emerging market, Saudi Arabia will reportedly make up about 4% of the emerging market index, which is definitely significant.

The Saudi equity market has been one of the most underinvested stock markets in the world, said Bill Mann, CIO of Motley Fool Funds. It represents great potential, he said, “so the opening of the bourse to foreign investors is a landmark event, and our calculation is that $50 billion from foreign investment could easily flow into the market.”

Of course, Saudi Arabia doesn’t have the greatest track record when it comes to human rights and for many investors, political risk will be a huge consideration when they look to investing in the country.

However, there are also a number of factors supporting the Saudi Arabian market that are leading more investors to look at the county with greater interest:

Strong Market Drivers

Randall Coleman, co-portfolio manager of Forward Management’s $160 million Forward Select Emerging Markets Dividend Funds, has been looking at the Saudi market with great interest for some time. He hasn’t invested as yet—Forward’s screening parameters are particularly stringent, he said. However, the market is attractive because “the secular drivers are very constructive to equity prices,” he said.

“Saudi Arabia has a very young population (more than half of its nationals are under the age of 30),”so that bodes very well for strong consumer growth,” Coleman said. Saudi Arabia’s middle class is expected to double from 20 million today to 40 million in 2050, according to data from the Organization for Economic Cooperation and Development (OECD), “so beyond the opening up of the market, there’s a very strong and supportive growth story there,” Coleman said.

A Highly Liquid Market

The Saudi equity market is extremely liquid and very retail driven, which makes it even more attractive to foreign investors like Coleman.

“People who are trading online from their homes make up about 90% of the market’s volume and the market trades around $2 billion a day,” he said. “Given that context, the prospect of foreign institutional investors coming in is very significant and trading for us will be cheaper and simpler, given the market’s liquidity.”

Diversifying Away From Energy

Saudi Arabia’s corporate sector is dominated by energy companies and that means they’re highly cyclical, “so if you’re concerned about the global economic cycle, they are more susceptible to a downturn,” Segal said.

It’s difficult given the country is more or less synonymous with energy, to diversify, and the stock market mirrors the economy.

The growth of the middle class, though, will help make the corporate sector more diverse, Coleman believes, and the Saudi government is also encouraging that dynamic by mandating companies to hire local Saudis (as opposed to being heavily dependent upon cheap foreign labor), and buoy their income levels so that consumption can grow. “The government is definitely proactive with trying to diversify away from oil dependence,” Coleman said.

Just as the opening up of the Chinese stock market—which to begin with, was much more diverse than the Saudi market—has helped bring in cash to further corporate development, “you can easily envisage equity capital leading to the appearance of a Saudi high tech giant quite soon,” Segal said, “and that would further increase the market’s appeal.”